Stopping 401k contributions

[Deleted]

Would you do it? would you come out ahead?

On my way to work this morning I heard someone on the radio (don't remember who) suggest to a caller that it would be on their best interest to go as far as stopping contributions to their 401k, pay off their debt first and they will be better off in the long run.

I am thinking is their math correct or are they looking at it short term?

And I am thinking of my wife and I , how would this work for us?
- Combined 93K
- 401K 25% (yeah wife paperwork finally went thru)
- All debts put together we are 160K in the hole and average out to about 7% interest.

Let's say we stop all 401K contributions for the next 5 years and focus on just debts. Would we come out ahead? That would be an extra 18K (after uncle sam take his cut) a year toward debt. We currently throw about 24K/year towards debt.

So instead of the 10 year plan we have now (credit card debt, car loan and student loans), it will be cut it in half but we would have no retirement when we are 31.

So what would you take?
- 36, retirement plan at about 300K and no debt
- 31, no debt with about 40K extra to spare

I did not factor in raises/promotions/cost of living increases.

[Wisconsin Beth]

Are you losing out on the compound interest if you stop the contributions now?

[qofcc]

At your income level, I think you're saving much more in taxes and getting more in the 401K matches than you're paying in interest. For someone in a lower tax bracket struggling to make ends meet, that might be good advice. Of course, if they were giving up free match money and the savers credit, it would not. The lower your income, the better advice this is.

[Deleted]

I just copied this from your other post, Cawaiu:


That is why everyone always suggest to start early this way you get used to living on less.

Start early and forget about it

[Deleted]

Apr 6, 2011 10:52:56 GMT -5 Wisconsin Beth said:

Are you losing out on the compound interest if you stop the contributions now?

We have about 15K in retirement now and the interest will keep on compunding.
We would just stop contributing to it.

[Deleted]

Apr 6, 2011 10:59:27 GMT -5 ArchietheDragon said:

I just copied this from your other post, Cawaiu:


That is why everyone always suggest to start early this way you get used to living on less.

Start early and forget about it

I am just playing with the math and how the advice on the radio would work for someone and since my finances are the only ones I have access to, I used it.

Does not mean I'm going to do it, just trying to figure it if you can really come out ahead doing what that person suggested on the radio.

[phil5185]

Examples -

Scenario 1:
Pay $3168/m for 5 yrs to clear the $160k loan, then put the $3168/m into a 10% index fund for 25 yrs. $4,113,000.

Scenario 2:
$160k loan @ 7% for 30 yrs = $1064/m. Concurrently put $2104/m into an 10% index for 30 yrs. $4,570,000

The return that you get on your investment is the key - if you average more than 7%, then it is better to keep the loan and invest your income. And if you get less than 7% it is better to prepay the loan.

[Deleted]

Phil we are currently paying about 2k/month towards our loans (sometimes more) and should be done paying them all off in 10 years not 30.

[cronewitch]

You personally wouldn't be better off. Your average interest isn't so bad and you can choose to pay down the higher interest debt first.

You wouldn't actually use all the extra money to pay debt it is too easy to decide to pay it next week, month, year and go ahead and ramp up lifestyle now.

You don't own a house so your tax rates are pretty high like 25% so your invested money only cost you 75% for now.

You might give up a match.

If you and your wife were in a pay down this awful debt from an disaster and you will never debt again mode and the interest rates were more than 20% it might make since if you have no match.

Paying down debt should hurt so you learn a lesson. If a person had say a car payment of $600 and every month they have to write the check even if they aren't eating food they like they might think twice about the next car. If someone steps in and pays it off for them they learn nothing except things always work out.

[tskeeter]

I think it depends on the interest rate on the debt and the amount owed. But, I probably wouldn't stop the retirement contributions. While, from a strictly financial perspective, it may be the best thing to do, I think you need to consider the behavioral aspects of a decision like that. First, you lose several critical years of compounded earnings. (Remember, you lose years at the end of the compounding period, when the dollars earned are the highest, not at the front when the impact of not saving appears to be minimal.) Second, relatively few people have the discipline to put all of the "excess" money into retirement savings once the bills are paid off. Suddenly having a lot of money that is not committed to paying bills makes it easy to reward yourself for a job well done and for lifestyle creep to eat into the funds available for retirement savings. This can further reduce the accumulation of a good retirement next egg.

[lynnerself]

Wouldn't tax strategies complicate this decision?
Takes saved now by investing in 401K, deductions for interest on student loans etc?

[Gardening Grandma]

O think there are too many unknowns for a pat answer.

Instead of a 10 plan for all debt (SL, cc, car), I'd create a plan to pay off the higher interest debts ( probably cc and car) asap and the SL later ( orif tbe rate is low enough not even accelerate the SL)
$160K is a LOT of debt, imo esp when none of it is mortgage.

What about trimming the 401k contributions back to enough to get the employer match and throwing that amount at the cc/ car debt with a goal of paying it off in 2-3 years?

[Gardening Grandma]

Phil
Please give me the name of that 10% index fund! ;-)

[phil5185]

currently paying about 2k/month towards our loans (sometimes more) and should be done paying them all off in 10 years not 30

Yes, $2000/m would result in a 9 yr payoff. What is the minimum payment? Is the 7% interest deductable? And what kind of products are you investing in?

[shooter47]

Wouldn't the deciding factor be the match and tax savings of investing in the 401k and the return on that investment for the next 9 years compared againist the interest rate of the debt and its tax deductibility?

[oreo]

Also keep in mind that it doesn't have to be all or nothing. You could contribute less than 25% to your 401K and use the "saved" money toward debt. You just need to pick an amount you are comfortable with.

[thyme4change]

I paid down my debt before I started saving, and I believe it was a mistake. I'm okay now, but only because we lived like poverty stricken hobos even when we were making more than $100k between us. Even now, our lifestyle is more simple than people who make far less money than we do. I still feel behind and wish that I had put something, anything, into 401k early in my life.

[Deleted]

Ok company match we would be losing out on:
- my wife: 2% of salary so $840/year
- me: 2.5% of salary so $1,325/year

The current plan right now:
- 7.3K in credit card debt at 0% till next Feb, trying to pay it all off by then.
- 15K on my car which is at 6.2% and have 2 years left on it.
- the remaining are student loans between 6.1% up to 9%. Some are 10 , 15 and 30 years repayment plan but we would like to have them all paid off in 10 years.

[alabamagal]

The decision should also be strongly influenced by whether the employer matches 401k contributions. If there is no match, you could be better off paying off the debt, then later you can put more money towards retirement. But if your employer matches, if you don't contribute, you are losing the potential match for as long as you don't contribute. You can never make up on the lost matching money.

One scenario that I always thought about (not recommending though, but interesting way to get people started on the 401k path). If you contribute so that your employer matches $1000 a year, and then later in the year you get into a real bind and need money. If you withdraw the money equivalent to your match and pay the penalty(10% penalty plus income taxes say 30%) you have to pay the government $400 but you get $600 out of it! And this is on your employer match (I know it all gets combined). If you did this, your money is still in your 401k! So my scenario says that you HAVE TO contribute to at least get the match.

[Gardening Grandma]

Apr 6, 2011 12:16:39 GMT -5 TheHaitian said:

Ok company match we would be losing out on:
- my wife: 2% of salary so $840/year
- me: 2.5% of salary so $1,325/year

The current plan right now:
- 7.3K in credit card debt at 0% till next Feb, trying to pay it all off by then.
- 15K on my car which is at 6.2% and have 2 years left on it.
- the remaining are student loans between 6.1% up to 9%. Some are 10 , 15 and 30 years repayment plan but we would like to have them all paid off in 10 years.

1) If your current plan has the cc's paid off by next Fed, I'd continue the contributions to get the company match and put the extra on the car. But only you know if you and the wife have the self discipline to do that instead of succumbing to lifestyle creep - and from what you've posted about her, that seems doubtful.

2) SL at 9%? Ouch! What is the length? I'd seriously try to get that paid off ASAP maybe even ahead of the car loan....

[Plain Old Petunia]

I'll bet you were listening to Dave Ramsey. DR advocates stopping all retirement contributions if you have debt. IMO, when given as "one size fits all advice", this particular nugget is just plain awful advice. DR also has ridiculously bad advice as to asset allocation and withdrawal rates (of your retirement nest egg).

You have to make a plan which make sense for you.

[Angel!]

Aren't you two maxing out your retirement contributions? If you are, then you would never be able to catch up later.

I could see stopping retirement for up to a year to get rid of some debt, I certainly wouldn't do it for five years. Something to consider to get rid of some of your 8-9% student loan debts, but I wouldn't do anything beyond that.

[Sum Dum Gai]

I personally wouldn't do it. Regardless of how the math works out you have to look at the psychological aspects of it. Would you really make an effort to put all the money back into retirement when you're done with the debt, or would your lifestyle creep up instead? What about your wife? She already likes to spend, and doesn't see the point of saving for retirement. Do you really want to set the precedent that debt and today's spending takes priority over retirement savings? Is she going to be disciplined enough to aggressively pay off the debt, then save for retirement, without running up more debt again later, or adding to the debt while trying to pay it off?

There's a lot more to it than just the math. Most people would probably lower the retirement contribution, thus losing out on the most amount of compounding, invest too conservatively when they do invest, and prioritize today's spending over saving for tomorrow. Most people also reach SS eligibility age with very little saved and are completely or almost completely reliant on SS to get by when they're old. The question you have to ask is, do you want to risk being that guy?

[txengineer]

Apr 6, 2011 12:16:39 GMT -5 TheHaitian said:

Ok company match we would be losing out on:
- my wife: 2% of salary so $840/year
- me: 2.5% of salary so $1,325/year

The current plan right now:
- 7.3K in credit card debt at 0% till next Feb, trying to pay it all off by then.
- 15K on my car which is at 6.2% and have 2 years left on it.
- the remaining are student loans between 6.1% up to 9%. Some are 10 , 15 and 30 years repayment plan but we would like to have them all paid off in 10 years.

cawiau, does your or your wife's 401K plan allow loans? If so, you can consider borrowing against 401k assuming the interest rate is lower. I'm considering this too. My 401k allows up loans to 50% of 401k balance and still keeps all your 401k money invested. Current interest rate is 3.75%. My only concern is if I change job, I may not be able to come up with a large amount of money to pay off quickly...

[schildi]

Apr 6, 2011 11:41:48 GMT -5 phil5185 said:

currently paying about 2k/month towards our loans (sometimes more) and should be done paying them all off in 10 years not 30

Yes, $2000/m would result in a 9 yr payoff. What is the minimum payment? Is the 7% interest deductable? And what kind of products are you investing in?

I think it's one of the 12% products. But there apparently is a severe shortage going on, so hope for the best!

[kindthatjingles]

I know I am going to get beaten, flamed and stoned on my response.

But as someone recently out of Chp 7

I was told repeatedly not to forgo contributions to my retirement or take out money from retirement funds to "help" my consumer debt situation. I am an example of someone who held on too long and should have done my BK a year ago. If your situation changes drastically (trust me I didn't see it coming) your consumer debt can be discharged. They can't take your retirement funds

Not advocating BK. Just coming from someone on the other side now. Keep up the investing.

I will be playing catch up for a long time....

Now hiding behind a lead curtain to deflect the Snark Masters on here

[phil5185]

Ok company match we would be losing out on:
- my wife: 2% of salary so $840/year
- me: 2.5% of salary so $1,325/year

I don't know what you invest it - but 5 years is $10,825 (free money). If you use 10%/yr items in your retirement fund, that will be $188,888 of your fund in 30 yrs - I would be careful not to miss out on that.

the remaining are student loans between 6.1% up to 9%. Some are 10 , 15 and 30 years repayment plan but we would like to have them all paid off in 10 years.

"like?". If you want to have wealth some day, you will need to retain the use of your inexpensive capital and put it to work - ie, don't prepay loans just because you don't like them. If there are some "low long" loans that can be separated, keep them. Eg, if there is a 6.1% 30 yr loan, keep it full term.

[RoadToRiches]

I did. For this year only. I was contributing 10% but then January I stopped to get my credit card debt paid off. The money I was contributing really is helping me out with paying off high interest credit card debt. I want to pay them off as fast as I can. Once I get to the two cards that are at 0% I am starting my contributions back again. It should be by November.

I understand where you are coming from though. Having those loans on your back probably makes you little frustrated. So you think how nice it would be not to have them and then you can concentrate on your retirement full time.

I know math looks better if you continue contributing, over 30 year period. That $100 you spend on dinner with your wife, will also look nice over 30 year period if you didn't spend it.

It's hard to get over that hump of thinking "no debt, debt is bad".

The more I read Phil's posts, the more I learn and the more I am thinking differently. I just need to get to that starting point. You are probably on a same boat as me. Want to pay off some stuff fast, but at the same time, want to do what's right and do retirement thing. Do what feels good, but take into consideration all the numbers.

In my case, I simply HAVE TO get out of my credit card bills, no matter what I have to do. Nothing else matters for me now. Why? Because I do not have that comfort money saved up in case something happens. If I did have it, which is the reason why I want to pay all this crap off, then it would be different story.

[Plain Old Petunia]

Apr 6, 2011 14:58:50 GMT -5 kindthatjingles said:

I know I am going to get beaten, flamed and stoned on my response.

But as someone recently out of Chp 7

I was told repeatedly not to forgo contributions to my retirement or take out money from retirement funds to "help" my consumer debt situation. I am an example of someone who held on too long and should have done my BK a year ago. If your situation changes drastically (trust me I didn't see it coming) your consumer debt can be discharged. They can't take your retirement funds

Not advocating BK. Just coming from someone on the other side now. Keep up the investing.

I will be playing catch up for a long time....

Now hiding behind a lead curtain to deflect the Snark Masters on here

That is a very valid point, Jingles. However, in Caiwau's case, his debt is primarily student loans which do not get discharged in bankruptcy.

[SVT]

Apr 6, 2011 11:33:04 GMT -5 Gardening Grandma said:

Phil
Please give me the name of that 10% index fund! ;-)

Is that sarcasm? Or are you not able to do any research on your own?